Every business needs a certain amount of money to meet its day-to-day working capital expenses. Working capital is crucial for the growth as well as the survival of a business. To address working capital deficiencies, businesses usually prefer working capital loans. However, banks require thorough research on the company’s working capital needs to approve the loan. This is where the MPBF (Maximum Permissible Bank Finance) method comes into play.
What is MPBF?
Maximum Permissible Bank Finance method, also known as MPBF method is a standardized approach used by banks to determine the maximum amount of working capital financing that a business can avail from them. It uses operational and financial parameters to calculate the working capital needs of a company. MPBF is the most common approach to calculating the working capital needs of a company.
Components of the MPBF method
Current assets: These are assets that are expected to be converted into cash within one year or less like cash, inventory etc.
Current Liability: These include liabilities that must be paid within one year. For example, accounts payable, short-term loans etc.
Expected Sales: The anticipated revenue predicted to be generated by a business over a given time.
Operating cycle: The operating cycle, represents the time it takes to convert raw materials into cash. It is essential for understanding the business’s cash flow patterns.
How is MPBF calculated?
We can calculate MPBF using the following steps:
1) Calculate the Working Capital Gap
To calculate the working capital gap, you need to subtract current liabilities from current assets.
Working Capital Gap = Current Assets – Current Liabilities
2) Determine the Margin amount
The next step you need to do is to find the Margin amount. Margin is the amount of working capital gap to be funded by own funds. Generally, the margin percentage will be 20%-25%.
Working Capital Gap x 25% = Margin amount
3) Subtract Margin
Lastly, you need to subtract the margin amount from the Working capital gap. The resulting amount is MPBF (The bank will provide the loan as the MPBF, i.e., the maximum amount)
Working Capital Gap – Margin amount = MPBF
Let’s understand the same with an example:
Suppose a company have the following data,
- Current Assets = 10,00,000
- Current Liabilities = 7,50,000
- Margin Percentage = 25%
Working Capital Gap = 10,00,000 – 7,50,000 = 2,50,000
Margin = 2,50,000 * 25% = 62,500
MPBF = 2,50,000 – 62,500 = 1,87,500
Here we can see that the Maximum Permissible Bank Finance or the maximum amount the business can obtain through the loan is Rs. 1,87,500.
Benefits of the MPBF method
- The MPBF method provides a framework for assessing working capital needs, ensuring a fair and consistent evaluation across different businesses.
- By understanding their MPBF limits, businesses can effectively plan their working capital requirements and confidently approach banks for financing.
- MPBF method provides insights into operating cycles and cash flow patterns. This directly helps in the decision-making process of the company.
Limitations of the MPBF method
- MPBF method does not consider seasonal fluctuations in the working capital needs of a business.
- It does not consider specific risks of the business such as inventory turnover, credit risk, liquidity risk etc.
- The MPBF method relies on past data. However, past data may not be indicative of future performance, especially if the business is experiencing growth.
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